Fed finally gets serious about inflation, recession risks 'more likely than not'

The US Federal Reserve raised interest rates by 75 basis points - the largest single move since November 1994 - in an attempt to finally get serious about sticky inflation.

The supersized rate hike brings the federal funds rate range to 1.50% to 1.75%, with more 50 or 75 bps increases on the horizon. 

“Clearly, today’s 75 basis point increase is an unusually large one, and I do not expect moves of this size to be common,” said Powell.

Why stocks are rallying

The Fed has been slammed for its delayed response to rising consumer prices and printing too much cash. An outsized rate hike signals to markets that the Fed is finally ‘moving expeditiously’ to fight inflation. 

The market shifted its expectations from 50 to 75 bps shortly after the higher-than-expected May inflation data last week. Anything more or less than 75 bps was likely going to see further selling, according to JP Morgan.

It’s worth considering that the markets were extremely oversold heading into the interest rate decision. The S&P 500 was down -10.2% in the five days prior to the overnight bounce.

In such dire circumstances, expected news is good news.

Just think back to May 4, when Powell said a 75 bp increase wasn’t being considered. The S&P 500 rallied 3% in that session, the largest rally in 2 years. 

Powell’s speech

Breaking down the highlights from Powell’s post hike speech:

• Inflation: Inflation risks weighted to the upside, Fed will be looking for compelling evidence that inflation is moving down. Median projection is 5.2% this year

• Interest rate outlook: Median projection is 3.4% at the end of this year, 1.5 percentage points higher than projected in March. Expects rates to reach 3.8% by the end of 2023

• GDP growth: Economic activity “edged down” in the first quarter, recent indicators suggest real GDP growth picked up this quarter, with consumption spending still strong 

• Labour market: Remains “extremely tight”. Fed expects supply and demand conditions to come into better balance, unemployment rate to rise from 3.7% year end t o 4.1% in 2024

• Property market: Housing sector appears to be softening due to higher mortgage rates 

• Quantitative tightening: “Continuing the process of significantly reducing the size of our balance sheet”

Recession seems more likely than not

Wells Fargo has changed its base forecast for the US economy from "an economic soft landing to a mild recession starting in mid-2023."

"Recent data suggests that inflation is becoming increasingly entrenched in the economy," said Chief Economist Jay Bryson. A more hawkish-than-expected Fed will "eventually depress interest-rate sensitive spending."

Encouragingly, Bryson observed that "many underlying fundamentals generally remain sound," including household and business balance sheets, and a well-capitalised banking system.

"We do not expect the downturn we are forecasting to be especially deep or prolonged."

He said that the Fed may still be able to pull off a soft landing, but the prospects now seem "increasingly less credible."